Two days to the end of SOTP enrollment deadline, and I'm more and more leaning toward participation in the program and sale of my eligible stock options.

Admittedly, the deal is not as sweet as when it was initially offered. The sharp decline of MSFT stock price after the Q1 earning release erased at least 40% of the value to most employees. The timing cannot be worse: an unfavorable earning release, impending danger of EU investigation, massive sell-off due to mutual fund scandals, just to name a few.

However, I still favor the participation due to the following observations:

1) MSFT stock was valued at $29 a month ago does not mean $29 is MSFT's fair value.

As a value investor myself, I feel MSFT was richly valued even at today's $26 price. With the FY04 EPS guidance set at between $0.86 and $0.88 (after equity compensation), $26 means MSFT is priced at 30x next year's earnings. For a company so big that it can only grow top-line around 10% every year, the price seems excessive for me. (Of course, there are more outragously priced technology companies today, but it does not mean MSFT's price is justified.)

To calculate its value, I'm trying Quicken.com's Intrinsic Value Calculator. By putting initial earnings as $9.5b (same as guidance for FY04), put earnings growth rate at 12% for 10 years and discount rate as 11% as S&P long-term return, it can yield the intrinsic value as $26. However, growing 12% YOY for 10 years mean 10 years from now Microsoft will be selling $100 billion dollars of software per year, or $20 per living person per year, no matter whether the person is infant or senior and no matter in which country the person lives. This sounds too optimistic for me.

For reference, here are some fair value estimate or price target from institutions, all after Q1 earnings release:

It appears none of them project a price higher than the break-even point for the SOTP decision.

2) Portfolio Risk Management Considerations

I believe everyone who is eligible for the program (therefore at least see MSFT is above $33 in one day in his/her employment in Microsoft -- this means hired before January 2002) has much more options below $33. Besides, many employees probably already accumulated lots of MSFT stock from ESPP or 401(k) program (disclosure: I have none in ESPP and 401(k) but my other options is 3 times more than options that are eligible for the program). Having additional stock options hanging at prices above $33 by not participating in the program and treating those options as lotteries is not a good idea for containing the risks in the personal portfolio. Even MSFT turns to $35 one year from now ($35 is the break-even price for participation/non-participation decisions in this game), people should gain much more from those options below $33 than those above $33. No-participation decisions may be a trophy if MSFT rises to $35, but in no way it's a good decision for risk management.

3) More Investment Choices If Partcipated

By selling the eligible options I can reinvest the after-tax proceeds to other investment opportunities. In addition, knowing that MSFT is going to be battered heavily during the averaging period (thanks to JPMorgan), it might be a good idea to buy some MSFT call options around December 10 as bottom fishing.

On the other hand, for no-participation decision, unless your broker lets you to write uncovered call options, there is no way to get some value out of the options until MSFT gains to above $33.

With the above reasons, I'm making up my mind to participate in the program. Of course I commit to only using the proceeds for reinvestment purposes. I'm not going to use it for a vacation or alike.